The Bacon Roll Theory - 16 October 2009

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I wrote a while ago about the impact on fragmentation caused by
an outage at NYSE Euronext (see The Croissant Hypothesis, April 2009). Well,
we had another chance to re-run the experiment here in London
this week. Basically, what happened was that on Wednesday the LSE
suspended trading in a small handful of stocks because of some
technical glitch in part of its market data feed. Spotting the
opportunity, all the MTFs enthusiastically emailed the market
confirming that they were still open for trading in the stocks in
question. But, just as happened in Paris back in the spring, the
expected surge in fragmentation failed to materialise and London
traders simply munched on their bacon rolls until the LSE fixed
the problem a few hours later.

This was shown by the fact that the average FFI of the stocks in
question (2.25) was, in fact, slightly lower on Wednesday than it
had been for the previous week (2.3).

This highlights, yet again, the subtle interplay between the MTFs
and the primary markets. There appear to be three reasons for
this. Firstly, the primaries are responsible for maintaining an
orderly market in the stocks they list and so traders are
reluctant to trade a stock without its "parent exchange" being
open. Secondly, a lot of liquidity providers use the primary
market price as the starting point for their calculations -
without this they simply can't make markets in those stocks.
Finally, there is the psychology of the market that still feels
that stocks "belong" to particular markets.

So, the paradox of the current situation is that without the
primaries the MTFs simply couldn't exist. The bizarre implication
of this, then, is that the LSE could beat the MTFs simply by
taking its ball home and refusing to come out to play at all but,
that way, everyone loses. More likely is that the calls for a
consolidated tape will be re-ignited yet again but, in order to
really fix the problem, any such tape would need to be fully
mandated by the industry. My suggestion is that we all get
together to define this and fix the problem - otherwise we may
find the regulators doing it for us.